The Good, The Bad and The Ugly: Reaction to Morneau’s 'Mandate Letter'

Prime Minister Justin Trudeau has made “mandate letters” to his ministers publicly available. These letters are intended to clarify the focus of each minister’s portfolio. The letter to new Finance Minister Bill Morneau (pictured above, with the prime minister) lists 27 priorities. In this blog post, we offer a quick reaction to 13 of these priorities.

• “Ensure that our fiscal plan is sustainable by meeting our fiscal anchors of balancing the budget in 2019/20 and continuing to reduce the federal debt-to-GDP ratio throughout our mandate.”

Our Reaction: This implies budget deficits in each of the next three fiscal years. That will mean 10 deficits in 12 years for the federal government, on top of the provincial deficits that are projected in this fiscal year (eight out of 10 provinces). Deficit spending can be justified during extreme negative economic shocks, but there is a danger that Canadian governments are returning to an approach to fiscal policy that routinely runs deficits as a matter of course, which led to the near fiscal crisis of the early 1990s.

• “Implement the middle-class tax cut and pay for it by asking the wealthiest one percent of Canadians to give a little more.”

Our Reaction: Canada’s personal income tax system is already uncompetitive—particularly the rates on middle- and upper-earners—compared to the United States and several other peer jurisdictions. High personal income tax rates discourage work, savings, investment and entrepreneurship; raising the top rate further would therefore undermine Canada’s competiveness and weaken our economic performance.

• “Cancel income splitting and other unfairly targeted tax breaks, while retaining income splitting of pensions for seniors.”

Our Reaction: Income-splitting partially removes a distortion in our tax system, under which families with similar household incomes pay very different levels of tax depending on who earns the money. There are better ways to deal with this problem, including simply removing the two middle-income tax brackets so that almost all Canadian households face the same top marginal tax rate (15 per cent). But in the absence of this type of fundamental reform, cancelling even partial income-splitting leaves an unfair tax distortion in place.

• “Meet with your provincial and territorial colleagues at your earliest opportunity to begin a process to enhance the Canada Pension Plan to provide more income security to Canadians when they retire.”

Our Reaction: A number of studies demonstrate that the core assumptions upon which the CPP expansion is based are false. The primary concern motivating a CPP expansion is that most Canadians are not saving adequately for retirement. However, as former Statistics Canada chief economic analyst Philip Cross demonstrates, a comprehensive perspective of saving behaviour does not support this view. And a major review of Canada’s retirement income system overseen by Prof. Jack Mintz also came to this conclusion (see also this important study by McKinsey & Company). Further, according to pension expert Malcolm Hamilton, the assumptions underpinning the claim that “few middle income [Canadians] have sufficient retirement savings,” are incorrect. There is no “retirement savings crisis” in Canada and therefore no need to expand the CPP. And the evidence suggests that when the government increases compulsory savings, households adjust by reducing their own voluntary savings, which may leave households no better off in terms of total savings.

• “Support the Minister of Employment, Workforce Development and Labour in delivering on our plan to make post-secondary education more affordable for students from low- and middle-income families.”

Our Reaction: Post-secondary education is an area of provincial responsibility. Ross Finnie of the University of Ottawa has done extensive research on the relationship between tuition and university access, speaking about the situation in Ontario (where tuition is, on average, higher than in most other provinces). He concludes that the current policy structure “by and large ensures accessibility for those who would otherwise face financial barriers.” Policy development in this area must be informed by an understanding that there is not a widespread problem in terms of financial barriers to post-secondary education at the undergraduate level.  

• “Work with the President of the Treasury Board and your Ministerial colleagues to conduct a review of tax expenditures and other spending to reduce poorly targeted and inefficient measures, wasteful spending, and government initiatives that are ineffective or have outlived their purpose.”

Our Reaction: Every year taxpayers spend a significant amount of time and money to file their taxes. The cost of complying with the personal income tax system alone is estimated at around $6 billion—or roughly $501 per household per year—and these costs fall disproportionately on lower-income Canadians who spend a greater share of their income complying. Tax expenditures add to the cost of filing an income tax return since claiming a tax credit or deduction requires keeping records, ensuring eligibility, and perhaps hiring an accountant to check if you’re not missing out on any tax benefits. In recent years, our tax system has grown unnecessarily complicated, partly due to the introduction of an array of “boutique” tax credits, which are not economically efficient. Cleaning up the tax code and broadening the tax base by removing tax expenditures would be beneficial, if it’s coupled with a reduction in tax rates so that the savings go to Canadians.

• “Work with the Minister of Infrastructure and Communities to develop the Canada Infrastructure Bank to provide low-cost financing (including loan guarantees) for new municipal infrastructure projects in our priority investment areas.”

Our Reaction: It’s not clear that the source of the problem is a lack of resources for municipal infrastructure projects. As research for Metro Vancouver demonstrates, collectively municipalities in the region have seen dramatic growth in their revenues over time. The real problem is that they have been unable to control the growth in their operating spending which has left less money for infrastructure initiatives. Further, Canada’s level of infrastructure spending is among the highest in the developed world, which casts doubt on the need for policy initiatives designed to significantly increase infrastructure spending.

• “Work with the Minister of Natural Resources to enhance existing tax measures to generate more clean technology investments and work with the provinces and territories to make Canada’s tax system highly competitive for investments in the research, development, and manufacturing of clean technology.”

Our Reaction: Generally speaking, governments should not try to identify “winners” and “losers” in the economy, either at the firm or industry level by providing preferential tax treatment. Of course, tax policy should be designed to make Canada’s tax system “competitive for investments,” but that should mean competitive tax rates across the economy rather than focusing on the creation of specific tax measures for a particular industry such as the “clean tech” industry.

• “Work with the Minister of Environment and Climate Change to fulfill our G-20 commitment and phase out subsidies for the fossil fuel industry over the medium-term.”

Our Reaction: No forms of energy should be subsidized over others, which means that singling out the fossil fuel industry in this way makes little sense. Ontario has experimented with significant subsidies for alternative energy providers through feed-in tariffs in recent years, with harmful results for the provincial economy. In fact, wind and solar power now represent approximately 20 per cent of the average commodity cost for electricity in Ontario, but provide only four per cent of Ontario’s electricity. Subsidies for uneconomic alternative energy sources have driven up power costs in Ontario, to the point that they are seriously damaging provincial competitiveness. Repeating this policy approach on a national scale would not be advisable. If the government aims to reduce subsidies in the energy industry, it should pay equal attention to subsidies that flow to providers of renewable energy. 

• “Restore the tax credit for labour-sponsored funds to support economic growth and help Canadians save for their retirement.”

Our Reaction: This is misguided move that flies in the face of the evidence on Canadian Labour Sponsored Venture Capital Corporations (LSVCCs), which are government-supported venture capital initiatives intended to encourage investment. Research led by Douglas Cumming and Jeffrey MacIntosh has clearly uncovered disappointing results whereby LSVCCs have displaced private venture capital funds and lowered the level of capital available to Canadian entrepreneurs. In fact, federal LSVCCs alone have resulted in more than 400 fewer venture capital investments per year in Canada, representing nearly $1 billion. LSVCCs have a horrible track record when compared to private venture capital funds and have yielded returns consistently below risk-free investments. It makes no sense to reinstate the tax credit for LSVCCs.

• “Work with the Minister of Innovation, Science and Economic Development to ensure tax measures are efficient and encourage innovation, trade and the growth of Canadian businesses.”

Our Reaction: Tax policy is essential to creating an environment that is conducive to innovation and entrepreneurship. However, at least one of the Liberals’ campaign commitments runs directly counter to this instruction. In their platform, the liberals pledged to cap the use of stock options, which would be harmful to entrepreneurship. Stock options are often used by cash-starved start-ups to increase the potential compensation of employees if the companies are successful. Caps would mean that Canadian companies will be at a disadvantage to attract and retain engineers, computer programmers and other professionals who can help drive innovation. This would be particularly harmful given that the high-tech industry is more mobile than traditional industries, which means firms are more likely to relocate in the face of an uncompetitive tax structure. If the Finance Minister wishes to comply with this component of the mandate letter, he should reconsider the campaign promise to cap stock options.
Instead, one of the most important ways that the government could use tax policy to promote innovation and entrepreneurship is by enacting capital gains tax relief. A recent research paper shows that reducing the capital gains tax burden improves the incentives for entrepreneurs and assists those financing business tart-ups. The study found Canada can “supercharge its entrepreneurial environment” by cutting the capital gains tax rate, or simply by eliminating the capital gains tax as has been done in many countries around the world.

• “Support the Minister of Employment, Workforce Development and Labour in improving and modernizing Employment Insurance and the job training system.”

Our Reaction: To truly reform Employment Insurance (EI) for the benefit of Canadians, the EI system needs to operate like a true insurance system where premiums are adjusted for the risk of making a claim. One of the many problems with EI is that premiums are not adjusted this way. Employers and workers pay the same premium rate regardless of claim history or occupation. Predictably, EI is prone to misuse since the system provides an incentive for seasonal employers to game the system by offering workers enough hours to qualify for EI, laying them off, and then rehiring them next season when they are needed again. The practice of experience rating would significantly improve EI because premiums would vary depending on one’s risk of making a claim. With experience rating, employers that regularly lay-off and rehire workers would pay higher premiums, as would workers who use the system more often.

• “Introduce a new tax benefit to help teachers and early childhood educators with the cost of school supplies.”

Our Reaction: This is in contradiction with the earlier instruction to eliminate targeted, inefficient tax credits. Low tax rates, not targeted (ineffective) tax credits to support specific purchases is the best way to encourage growth and ensure a fair, competitive tax system.